Expiration Hangover, Turnaround Tuesday, And Other Clichés

08/18/08 3:35 PM EST

As of: SPX 1251 HELP  ARCHIVE

Lingering concerns over Fannie and Freddie have left a big mark on the Financials today, and that's seeping into the broader market.

We went over some correlations on Friday which showed Banks and the Dollar having a larger impact on the S&P 500 than Oil, and we're seeing that take root today.  Banks are getting hammered, and the Dollar Index is dropping, offsetting any potential positive from lower Oil.  We can't always rely on these inter-market correlations to hold up, but today it seems to be following the recent pattern and is the reason why these assets are first and foremost on my monitors.

While there is often some weakness following option expirations, particularly when the market gaps up as we discussed this morning, August hadn't really followed that pattern too consistently.

Today it certainly is, as the S&P has sold off more than 1.5% the day following an option expiration for the first time since last November, after which the market chopped around for a few days before rallying strongly.  Since 1983 (when index option trading began taking off), there have been 49 times when the S&P sold off 1% or more the day following option expiration.  Buying Monday's close and holding for three days resulted in 76% winning trades averaging +0.9%, so typically we did see the selling pressure back off more often than not.

That probably has less to do with option expiration than it does Mondays in general.  We've gone over the "Turnaround Tuesday" phenomenon before, which theorizes that the market tends to reverse extreme moves during the middle of the week.  Looking at any time Monday was down 1% or more since 1983, the next three days were up 73% of the time with an average of +1.0%.

Like we went over last week, we should expect to see exceptionally low volume over the next couple of weeks, and today isn't disappointing in that regard.  We're currently on pace to record the lowest non-holiday volume in nearly two months, though that could change with a burst into the close.  I checked the history of the S&P 500 to find any other time it sold off 1.5% or more on a Monday while recording the lowest volume in a month.  Not surprisingly, there were few occurrences - only three - and all three led to short-term rallies over the next several sessions (they were 06/03/80, 05/04/81 and 11/11/02).

Relaxing the parameters and looking for 1% declines upped the number of occurrences to 22, but led to short-term rallies "only" 60% of the time, with a slight positive return.  Over the past 30 years such conditions have been positive, leading to rallies 70% of the time, but prior to that we run into the nasty mid-1970's which drags down the positive expectation considerably.

Today's selling pressure has moved several of our most sensitive indicators into oversold territory, and the S&P in particular is right back to that 1275ish area we've discussed several times over the past month.  That also happens to equate with the uptrend line from the July low, something pretty much every technician likely has drawn on their charts at the moment.  So we're seeing another "oversold on support" setup, in which case we shouldn't see much more weakness particularly given the Turnaround Tuesday idea.  Allowing for some follow-through weakness tomorrow morning, if we can't rally heading into Tuesday afternoon then my guess is we're going to have a date with 1250 again on the S&P.

As Volume Slows, Edges Become Harder To Find

08/18/08 9:45 AM EST

Good Monday morning...We begin the day with mixed trading in the major equity averages after another mostly-quiet weekend news flow.  Commodities are mixed as well, and foreign markets had a mostly positive (but minor) uptick.

There has been a marked tendency over the years to see weakness following an option expiration, one of the few consistent biases we see surrounding these monthly events.  The bias tends to get stronger if the market gaps up on the day following an expiration, like we're seeing this morning.

In the history of the S&P 500 tracking fund, SPY, there have been 56 times when it gapped up +0.25% or more the morning after an option expiration.  Buying the open and holding 'til the close resulted in only 39% winning trades and an average return of -0.1%.  Over the past five years, the winning percentage dropped to 33%, though overall the maximum drawdown and maximum reward were both well under 1%, suggesting that we mostly saw only minor moves, skewed to the downside.  Following August expirations, the S&P went 4 for 7, so there wasn't as much of a negative bias on this particular month.

I mentioned last week that so far, I haven't been able to find much on an intermediate-term time frame that would counter the studies we went over on July 15th and during the following week, which called for a one- to three-month equity rally.  We're bumping up on the lower end of the typical rally we see off those conditions, both in terms of time and average returns, so often we'll begin to see some studies suggesting the rally is about to peter out.

The latest data from last week isn't making that case too strongly.  The Commitments of Traders report, which has lost some usefulness in the equity index futures, showed that large commercial hedgers (aka the "smart money") increased their net short position in S&P 500, Nasdaq 100 and DJIA futures to $8.8 billion from $6.6 billion the prior week.  That's their largest short since a one-week outlier this past January, and early 2007 before that.  But small speculators, usually considered "dumb money", is still showing one of their lowest net long positions in the past several years.  Those two data points are somewhat conflicting, and they don't leave us with a solid conclusion either way.

The latest data on the smallest of options traders, trading 10 contracts or less at a time, didn't show much movement last week.  They spent 34% of their volume buying speculative call options, down just a tad from the prior week.  They also spent 21% of their volume buying protective put options, also down a tad from the week before.  That left our ROBO Put/Call Ratio unchanged on the week and not giving us much of a sign one way or the other.

As we went over on Friday, there are some sectors and asset classes showing very high correlations to the S&P 500 over the past month, with the greatest ones being movements in the BKX Banking Index and the U.S. Dollar.  These correlations are always changing, but so far those two have been consistent and even strengthening, so they both should be watched going forward.  Some of our sentiment guides for the Dollar are getting extremely stretched, and if the currency takes a breather - and its positive correlation to the S&P holds up - then that should serve to be a headwind for stocks in the coming week(s).

On Thursday, we went over the fact that we're now entering one of the very lowest-volume periods of the entire year as traders take off on their last summer vacations before the school year begins.  While volume will be exceptionally low, that doesn't mean that we won't see volatility in stocks, as the VIX actually tends to rise this time of year and their is no discernable drop in intraday movements.  Those movements should become more choppy and whippy, particularly during the mid-day, so those trading on very short time frames should beware the lull outside of the first and last hours of trading.  Directionally, there hasn't been much of a positive or negative bias during the last weeks of August, except for a slight positive burst over the next couple of days, and again immediately before the Labor Day holiday.

With our short-term guides neutral, and a lack of clear edge among the sentiment-, breadth- and price-based measures I follow, I'm not doing much of anything trading-wise.  I'm still holding some intermediate-term longs based on the stuff we discussed in July, and not seeing much of a reason to change that just yet.